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Capitalism

Capitalism, unlike Islamic economic system and Socialism regards capital as an


individual factor of production creditable of distinct factor payment i.e. interest. It
supports the capitalists to benefit from wealth accumulation without having to put
factor i.e. capital at similar risks that an entrepreneur faces. It shifts the break even
line further away from the entrepreneur and crowds out entrepreneurs who cannot
afford to keep feeding capitalists. In this regard, interest has a huge influence on
allocation of resources. It influences the basic economic decisions like what and for
whom to produce.
Capital is needed for technological advancements. It is needed for production and
consumption and for governments to expend on development. It is even needed to
influence policies by winning elections after expensive election campaigns. There
would not have been many complexities if markets were efficient and income and
wealth distribution fair. But, the world we live in has never and perhaps never will
have perfect equality and perfect competition.
Interest serves capitalists and allows them to accumulate wealth. This is evident
from the empirical statistics on inequality in income and wealth in second half of the
20th century when monetary capitalism with institutional support expanded in an
increasingly integrated and global economy.
In 2001, there were 1,100 million people living in poverty. But in Sub-Saharan Africa,
the number of people in extreme poverty rose to 313 million. (Source: World
Development Indicators 2005)
Hence, much of the technological advancements, increase in production and better
standards of living with increase in earning opportunities and welfare expenditure
has occurred in that part of the world which was able to accumulate capital
effectively than the rest of the world in precapitalistic and early capitalistic eras.
Economic Management in Capitalism
What to Produce?
Countries produce the goods domestically in which they have comparative
advantage and trade the other goods from other countries in which they do not
have a comparative advantage. Most countries however strive to have food security
and engage in agricultural production even if they do not have comparative
advantage in producing farm goods. For instance, most OECD countries do not have
comparative advantage in agriculture, but they provide huge subsidies to their
farmers to enable domestic production for food security.
How Much To Produce?

Therefore, countries have to trade-off one good for another between the set of
goods that they can produce. The opportunity cost of each good for each country
determines the level and variety of output for that country.
How to Produce?
Cost minimization gives a country comparative advantage in gaining access to
other markets and countries. Decrease in price increases demand and revenue (up
to a limit). Cost minimization enables a country to increase its production of all
goods and services with the same existing amount of resources.
When to Produce?
Countries have to make decision about future production well in advance to meet
the demands of increase in population, changes in tastes and preferences and
changes in income. Countries have to produce domestically the goods in which they
have comparative advantage and import the other goods to meet demand and to
avoid high inflation.
For Whom to Produce?
Resources are allocated to produce goods that can be bought in the market by
people having adequate purchasing power. Purchasing power and current and future
income prospects determine the size of the target market and triggers the
producers to meet expected demand. Decisions about production are driven by selfbenefit and profit maximization objective.
Fundamental Features of a Capitalistic Economy
Capitalism is a natural economic system unlike socialism. That is why; it has fared
well throughout history, practiced most widely and has outmoded Socialism. Most
Socialist countries have adopted features of Capitalism and the growth of China
since 1980s after it made a compromise between Capitalism and Socialism (though
still not in a holistic way) and adopted some of the important Capitalistic values
further strengthen the case to use Capitalism (though modified to suit the needs of
a particular country) over outright Socialism.
Right of Private Property
In a capitalistic economy, people have the right to own assets and conduct
business. Within legal limits, they have the complete freedom to enter into any
business activity be it socially or morally correct or not.
No Government Intervention
Government does not intervene or its intervention is very minimal. Businesses are
allowed to produce anything and charge any price they wish as long as they can

find buyers who can afford their goods and services. Therefore, a capitalist seeks
maximum return for his capital and keeps all things secondary to it.
Freehand to Market Forces
Market forces of demand and supply are allowed to work freely. Government does
not intervene in setting the prices or level of output in a model capitalistic economy.
Reliance on Invisible Hand
It is assumed that every person acting in his/her own benefit will keep the economy
running in an efficient way. Everyone is allowed to work in his/her benefit and is not
obliged to think about society and its needs. It is assumed that social objectives will
be met with people working for their own benefits.
Freedom of Choice in Production
People have outright freedom in production. A capitalist having a higher incentive to
produce luxury bungalows and lower incentive to produce low cost apartments will
produce luxury bungalows. All decisions are governed by incentives and self benefit
and no consideration is given to the needs of the society. Invisible hand is supposed
to bring socio-economic order.
Freedom of Choice in Consumption
People have outright freedom to consume whichever goods they like as long as they
can afford them. Consumers seek maximum utility and do not have obligation to
share their wealth with the poor masses apart from compulsory taxes. Materialism,
self benefit and apathy are the hallmarks of the capitalistic society.
However, in most capitalistic countries, government does play a role and impose
taxes to deal with externalities, identify and correct anti-competitive practices,
provide subsidies to support a commercial project which may not be attractive for
private investors from the viewpoint of NPV and thereby subsidies provide incentive
to undertake these projects. In most capitalistic countries, defense, utilities,
communication, transport etc are run in public sector.
Critical Analysis of Capitalism
Interest is prohibited in all monotheist religions (See Exodus 22:25, Leviticus 25:3536, Deuteronomy 23:20, Psalms 15:5, Proverbs 28:8, Nehemiah 5:7 and Ezekiel
18:8,13,17 & 22:12). However, interest is pervasive in capitalism.
Even among secular literature, one finds criticism on interest. Aristotle (384-322 BC)
in his book Politics criticized interest in following words Of all modes of getting
wealth, this is the most unnatural". In value neutral economics too, we find criticism
on interest. Keynes (1936, p. 377) in his monumental work General Theory of
Income, Employment, Interest and Money reasoned in following words:

Interest to-day rewards no genuine sacrifice, any more than does the rent of land.
The owner of capital can obtain interest because capital is scarce, just as the owner
of land can obtain rent because land is scarce. But whilst there may be intrinsic
reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of
capital. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice
which could only be called forth by the offer of a reward in the shape of interest,
would not exist, in the long run, except in the event of the individual propensity to
consume proving to be of such a character that net saving in conditions of full
employment comes to an end before capital has become sufficiently abundant. But
even so, it will still be possible for communal saving through the agency of the State
to be maintained at a level which will allow the growth of capital up to the point
where it ceases to be scarce.
In one of his famous essay, Keynes (1932, p.358) reasoned as follows:
When the accumulation of wealth is no longer of high social importance, there will
be great changes in the code of morals. We shall be able to rid ourselves of many of
the pseudo-moral principles which have hag-ridden us for two hundred years, by
which we have exalted some of the most distasteful of human qualities into the
position of the highest virtues. We shall be able to afford to dare to assess the
money-motive at its true value. The love of money as a possession as
distinguished from the love of money as a means to the enjoyments and realities of
life will be recognized for what it is, a somewhat disgusting morbidity, one of
those semi-criminal, semi-pathological propensities which one hands over with a
shudder to the specialists in mental disease ...
But beware! The time for all this is not yet. For at least another hundred years we
must pretend to ourselves and to everyone that fair is foul and foul is fair; for foul is
useful and fair is not. Avarice and usury and precaution must be our gods for a little
longer still. For only they can lead us out of the tunnel of economic necessity into
daylight
Milton Friedman, one of the most distinguished monetary economists argued that
nominal interest rate be kept at zero. He reasoned that the marginal cost of creating
additional money is zero. Therefore, nominal rates of interest should be zero. It
implies that the central bank should keep rate of deflation equal to the real interest
rate on treasury bonds so that the nominal interest rate are kept at zero. This also
obviates the need for indexation and it also helps in increasing output and
employment.
Among the most recent economists, Krugman [September 02, 2009] in his New York
Times article titled How Did Economists Get It So Wrong? analyzed the current
financial crisis in following words:
Until the Great Depression, most economists clung to a vision of capitalism as a
perfect or nearly perfect system. That vision wasnt sustainable in the face of mass

unemployment, but as memories of the Depression faded, economists fell back in


love with the old, idealized vision of an economy in which rational individuals
interact in perfect markets, this time gussied up with fancy equations
Unfortunately, this romanticized and sanitized vision of the economy led most
economists to ignore all the things that can go wrong. They turned a blind eye to
the limitations of human rationality that often lead to bubbles and busts; to the
problems of institutions that run amok; to the imperfections of markets especially
financial markets that can cause the economys operating system to undergo
sudden, unpredictable crashes; and to the dangers created when regulators dont
believe in regulation.
So heres what I think economists have to do. First, they have to face up to the
inconvenient reality that financial markets fall far short of perfection, that they are
subject to extraordinary delusions and the madness of crowds.
Sameulson (1948) in his criticism on extra reliance on market forces stated that
market forces will only lead to starving couples to malnourished children who grow
up to produce malnourished children, to perpetuation of Lorenz curves of great
inequality of income and wealth for generations or forever.
Among Muslim Economists, Siddiqui (2002) criticized interest stating that even in
commercial loans, the borrower may suffer a loss, yet interest based lending obliges
him/her to repay the principal plus compound interest. Conversely, the borrower
may reap huge profits, yet the lender gets only the stipulated rate of interest which
may likely turn out to be small part of the actual profits. It results in inefficient
allocation of societys resources and increases the inequality in the distribution of
income and wealth as it guarantees a continuous increase in the monies lent out,
mostly by the wealthy, and puts the burden of bearing the losses on entrepreneurs
and through loss of jobs on the workers.
Chapra (1993) viewed secular societies continuing to belittle the need for moral
development; though all of them now profess commitment to development with
justice. He emphasized that even material development with justice is not possible
without moral development. The rationale for this contention is that development
with justice requires an efficient and equitable use of all resources and both
efficiency and equity can neither be defined nor actualized without the injection
of a moral dimension into economic pursuits.
He outlined unrealistic assumptions in capitalism which will not make invisible hand
alone to address the issues of equity:
1. Harmony between individual and social interest e.g. unscrupulous consumption
and imposing externalities on society.
2. Individual preferences reflect social priorities e.g. precedence of self interest over
social priorities.

3. Equal distribution i.e. unequal distribution of income gives more weight to


resourceful class to influence allocation of resources to their desired use.
4. Prices reflect urgency of wants i.e. no mechanism to differentiate between
necessities and not so necessities, e.g. want satisfaction of few does not mean need
satisfaction of all especially when resources are scarce and can only be used for
alternative uses.
5. Perfect Market i.e. price mechanism can have a minimum impact on socially
desirable allocation of resources; it works when there is perfect competition. But,
market imperfections even dilute this little influence that price mechanism could
have on socially desirable resource allocation when prices are completely out of line
with real out-of-pocket costs. Such programmes have very serious negative
impacts on growth, inflation, income distribution, the social sectors, and poverty. In
general, Structural Adjustment Programmes have made matters far worse for
countries that have followed them. We have examined the philosophy that governs
such adjustment programmes, which is essentially one of liberalization, openness,
and greater integration with the new economic world order, and we have found that
not just the adjustment programmes themselves, but also the thinking behind them
does not take account of specific factors and the context of specific countries.
In WTO system, developing countries are given some extra time to restructure
themselves than the developed countries. But, the time limit is very short for an
economy to restructure itself. Small economies with little population are able to
restructure themselves like some of the East Asian countries. But, the tropical
countries with agrarian economies and huge population are not able to restructure
themselves so quickly.
Industrial revolution came in mid 18th century. Capitalism as we know had its roots
in as early as in the 15th century. Even then, the change from agrarian based
economy to industrialized economy was not rapid. Similarly, information revolution
in the last two decades needed a maturing industrial revolution as a preset.
Therefore, if it took centuries for Europe to restructure their economies, how can
developing countries are expected to restructure themselves in less than a decade!
The shallowness of the WTO is evident from the fact that it has not addressed
following key areas in international trade and politics.
-

Oil trade is completely out of WTO influence

No agreement on smuggling

No agreement on anti-money laundering

Drug trafficking is out of WTO influence

Need for Redefining Priorities

After providing exemplary standard of living to their citizens, developed countries


embarked upon providing such luxury to animals as well. But, humans should have
more value than animals! This assertion will not look odd when they will have to
trade off between their citizens and engendered species! Using TBT (Technical
Barriers to Trade), SPS (Sanitary and Phyto Sanitary) measures, environmental
excuses and safety measures for saving extinct species while the developed world
is responsible for most of the worlds pollution and climatic change is completely
baseless. Highincome countries account for half the worlds Co2 emissions (Source:
Carbon Dioxide Information Analysis Center data).
Less is better if it is distributed fairly equally than more wealth distributed
unequally. Efficiency measures need to include social objectives. Priorities need to
be set right and there should be a worldwide consensus on the following issues:
Growth Vs Development
Growth is important but development is pivotal. Growth that does not result in
development is less desirable. Reducing inequality is more important than
increasing the growth rate.
Profit Optimization Vs Social Optimization
Social Optimization is more important than Profit Optimization. Achievement of
social optimization if not possible solely through the private sector, it must be
brought about through government intervention.
What goes around comes around!
Reducing trade barriers was said to benefit consumers as they will have range of
competitive products at their disposal. But, consumers earn through factor
payments that come through producers. If domestic producers will be crowded out
of the market in a no-trade barrier regime; then, consumers will lose jobs and their
purchasing power will decrease subsequently. Furthermore, it may also cause brain
drain. Therefore, in the long run, it merely becomes a zero sum game.
Summarily, as a capitalist, one even with the knowledge that weapons one sells will
kill millions in Africa, would not bother as that is what he does for profits as a
capitalist. Though, one may favor democracy in principle, but if nationalistic
interests are better served by dictators, one will bear them as a head of state of a
country in a developing country. Though, one may favor progressive taxation in
principle, but if indirect taxes can pay back loans smoothly, one may direct
imposition of indirect taxes in developing countries as a chairman of IMF or World
Bank

Socialism
Some of the pioneer and well known social thinkers include Robert Owen, Charles
Fourier, Pierre-Joseph Proudhon, Louis Blanc, Charles Hall and Saint-Simon.
Socialism was to act as a pre-cursor to Communism. Karl Marx described socialism
as a specific historical phase that will displace capitalism as a precursor to
communism. Socialism does not promise to make everyone equal and pay everyone
the same wages and replace market economy in a complete sense. However,
communism does promise income and social equality. Some of the well known
social leaders include Vladimir Lenin and Joseph Stalin. Some of the important
countries that tried Socialism include Russia, Hungary, Poland, Romania, Vietnam,
Yugoslavia etc. Just before Great Depression, the socialist movement was at its
peak. Most socialist countries fared very well in Great Depression and only Capitalist
countries suffered in Great Depression. This also caused appreciation for Socialism
at that point in history.
Fundamental Features of Socialism

The salient features of Socialism are discussed below:


Collective property
In a socialist economy, there is no right to own private property. All the property
collectively is in the ownership of the socialist government in the country. This
means that all the business enterprises are in the collective ownership,
management and control of the government.
Planned Economy
The government in its own wisdom solves the central problems of the economy.
Decisions like what to produce? how to produce? when to produce? for whom to
produce? and how much to produce? are all taken by the government. All the
economic planning and policy making rests with the government.
Decisions in Collective Interest
All the decisions are made by the government in the collective interest of a socialist
country. People are directed to follow the instructions of the government and are not
allowed to object to any decision or policy of the socialist government.
Reduced Income Inequality
Government makes the decisions about the wages arbitrarily. The wages are forced
to remain in parity in all fields. Government tries to keep income equality through
setting the wages and disallowing any objection or bargaining.
Restriction on Market forces
Market forces of demand and supply are not consulted by the government in a
socialist economy. Market mechanism does not prevail and all the decisions are
made by the government in its own wisdom.
Centralized Economy
All the decision-making authority rests with the government. No one else is given
the authority to make the economic decisions even for oneself. Everyone has to
follow the commands of the government and everyone is treated like an employee
of the government.
Non-existence of Private sector
Private sector is non-existent in a socialist economy. No private economic activity is
allowed. Every person has to work for the government and earn wages that are set
arbitrarily and are not determined on the basis of quality or nature of the work.
Critical Analysis of Socialism

On the economic criticism of Socialism among Muslim economists, Maududi (1970)


analyzed that socialism in its quest to tame capitalists brought one big capitalist in
the form of government i.e. communist party accredited with the responsibility to
operate, manage and administer the overall economy without giving society and
individuals any recourse to challenge the government. In such a case, no
government, consisting of humans after all can keep itself judiciously pursuing
common goals than individual goals. Usmani (2003) reasoned that socialism kills
the self motive which drives individuals to excel and be efficient.
The predictions of Marx about Capitalism also did not materialize and his Theory of
Surplus Value was also criticized later on. The problem in distribution of income in
Capitalism from an Islamic perspective was only with interest. Land has an intrinsic
value and its owners receive rent on land. Labor also earns wages even when the
entrepreneur suffers loss. Value of production i.e. prices of goods is not always
sufficient to create surplus after paying wages, rent and interest. While laborer
earns wages for work it renders and the land owner earns rent for the use of land,
money cannot have a separate compensation of its own until it transforms itself as
capital and take the risk of entrepreneurship along with an entrepreneur.
Toutounchian (2006) also differentiated between money and capital and reasoned
that if capital is combined with labor, it produces profit, but if money alone is lent,
the interest it earns is not permissible. Schematically, he reasoned as follows:
M :{( 1) L=100%; (2) V>1; (3) MC=0; (4) d=0; (5) =0; (6) R=r}
K :{( 1) L<100%; (2) V=1; (3) MC>0; (4) d>0; (5) >0; (6) R=}
Where: L= liquidity; V= velocity; MC= marginal cost; d= depreciation
R = return; = risk; r= rate of interest; and = rate of profit
On the political criticism of communism, Fukuyama (1992) argued that following the
collapse of the Soviet Union, liberal democracy no longer faced any serious
ideological challenges and thus had proved itself to be the only sustainable and
successful form of government. Marx used the phrase 'the end of pre-history' to
symbolize the victory of communism over capitalism. Fukuyama claimed that
capitalist liberal democracy would ultimately extend to all nations and this would be
'the end of history'.